Amazon (AMZN) Q4 Earnings Preview and Trade Ideas

by Dan February 2, 2017 1:01 pm • Trade Ideas

Event: Amazon (AMZN) will report Q4 results tonight after the close. The options market is implying about a 5% one day move tomorrow which is well shy of the 4 quarter average post earnings one day move of 7.5%. The at the money weekly straddle is offered at $42. If you bought that and thus the implied earnings move, with the stock around $840 you would need a rally above $882, (above the $847 all time high) or a decline below $798 by tomorrow’s close to make money.

As was the case with Facebook (FB) yesterday into its Q4 print, the technical set up is treacherous when you consider the stock’s 12% year to date gains, with the stock just below the prior all time high made in late October (which was prior to their Q3 results):

Bloomberg

Also, much like FB, during its Q3 conference call in late October Amazon guided operating expenses higher, which rattled investors at the time. As I discussed this morning (here), the fact that FB management reiterated their stance from early November that ad growth would continue to moderate, and expenses would rise this year should not have come as a surprise to investors. If they chose to ignore this guidance, and merely view it as sandbagging, that would certainly suggest a massive sentiment shift, when you consider both AMZN and FB took nearly two months to shake-off this very commentary in November and December of 2016 post results before their 2017 heroics.

I don’t have much to add on the fundamentals or valuation on AMZN, they have not seemed to matter much of late. RBC Capital’s Mark Mahaney highlighted the following “critical factors” to watch for in the Q4 print, in a note to clients earlier in the week:

  1. Gross margin trends– We estimate Q4 GMs of 32.9%, +100bps Y/Y;
  2. Overall Operating margin trends– We believe investments in international markets (esp. India), logistics infrastructure, AWS, Original Content and in a range of Pillar Projects will continue weighing on profitability. We look for a 2.4% GAAP operating margin in Q4, down 70 bps from Q4:15;
  3. Key AWS Results– We are looking for AWS Revenue of $3.6B, +50% Y/Y and AWS GAAP Operating Profit of $969MM (a 27% margin);
  4. Key North America Retail Results– We are looking for NA Retail Revenue of $26.0B, growing 21% Y/Y, and NA Retail GAAP Operating Profit of $650MM (a 2.5% margin); and
  5. Key International Retail Results– We estimate International Retail Revenue of $14.4B, +24% Y/Y ex-FX, and Segment Loss of $550MM.

While AWS is expected to be less than 10% of AMZN’s total sales in Q4, the operating profit of nearly $1 billion is a disproportionate amount of the company’s expected quarterly operating profit.  The pie is big in the public cloud, but if MSFT and GOOGL’s results and commentary last week showed us anything, it is going to be a massive battle with many other motivated and formidable entrants like Alibaba coming in a big way. I would be shocked if operating margins were above 30% again. But their healthy lead in the cloud and the expansion into other cloud based services like AI, will be a massive driver for the stock and continue to subsidize their sub 2% operating margins on the balance of their $100 billion plus in sales.  Again though, just like Zuck, who actually took a page out of Bezo’s playbook, AMZN has laid out the long term plan, they make no bones about the lack of profitability in 85% of their sales and continue to spend on creating platforms like Echo in voice that has become the clear leader in what is becoming one of the most disruptive tech platforms at the moment. Original content spending I am less excited about, but they are clearly focused on offering Prime members content, services and products that are offered everywhere else on the web in an effort to become a one stop shop.

So it’s not just happy customers that AMZN creates, but also very happy investors, and clearly analysts, with sentiment towards the stock off the charts, with 43 Wall Street analysts rating the stock a Buy, with only 5 Holds and NO Sells, with an average 12 month price target of $947, or 12% higher than current levels.

It is a fools errand to attempt to pick tops in stocks like this, but FB’s price action, given many similarities pre-earnings (here) might prove to be instructive to how AMZN trades tomorrow.

So what’s the trade?

Those looking for a breakout should do so with defined risk with a stock alternative/replacement:

In lieu of 100 shares of AMZN ($840) Buy the Feb 840/880/920 call fly for $9
  • – Buy 1 Feb 840 call for 25
  • – Sell 2 Feb 880 calls at 9.50 (19 total)
  • – Buy 1 Feb 920 call for 3

 

Rationale – This defines risk to $9 (versus the implied move of $42) and targets a move close to that implied move on the upside. It can be worth up $40 if the stock is 880 on Feb expiration. Most importantly, if the stock declines, the most that can be lost is $9. If the stock were to go significantly higher through the 880 target, there is risk of losing money, but not until $911. The profitability range of 849 to 911 is quite a target, and the break-even of 849 is just 1% above where the stock is now.

 

OR for those long and strong AMZN stock, a hedge makes sense to protect against disaster:

vs. 100 shares of AMZN ($840) Buy the Feb3rd 800/880 collar for .50
  • – Sell 1 Feb3rd 880 call at 4.50
  • – Buy 1 Feb3rd 800 put for 5.00

 

Rationale – This collar caps gains in the stock at the implied move on the upside, but also protects against disaster below 800. It’s most likely scenario is losing just .50 if the stock moves inside the implied move. If the stock outperforms on the upside some profits are lost, but that’s after realizing 41.40 of those profits. If the stock declines below the implied move there are no losses below 799.50.